In recent posts here, I have argued as to the effectiveness of various forms of measurement and their utility in managing outcomes.

I have just posted in further detail on our firm website (and, to keep Ron and Ed happy, I haven’t referred to cricket, but rather Aussie Rules football). I encourage you to have a read – let me know what your thoughts are.

Harvard professor Clayton Christensen is one of my favorite business thinkers, right up there with Peter Drucker, Henry Mintzberg, Gary Hamel, and a couple of others.

Unlike most business writers, Christensen understands the importance of theory. He writes:

MANY BUSINESS RESEARCHERS, consultants, and writers create and sell us static views—snapshots—of technologies, companies, and markets. [These] tell us little about how they got there. Nor do they tell us what is likely to happen in the future. My colleagues, my students, and I have eschewed the profession of photography. Instead we are making ‘movies’ of management.

This book applies the same concept of using theories to what’s important in your life. He begins by talking about knowing some of the leaders caught up in recent scandals, like Jeffrey Skilling from Enron, a Harvard graduate. The book sets out to help you answer three questions with respect to “How will you measure your life”:

How can I be sure that I will be successful and happy in my career?

How can I be sure my relationships with my spouse, my children, and my extended family and close friends become an enduring source of happiness?

How can I be sure to live a life of integrity—and stay out of jail?

The last one about staying out of jail may seem unnecessary, but given the number of Harvard MBAs who have ran afoul of the law in recent times, perhaps not.

What’s interesting about this work is that it applies the same logic of using theories, which Christensen uses in his work with business leaders, to your personal life. It’s only theories that allow us to peer in the future, since conclusive data is only available about the past.

I Don’t Have an Opinion, the Theory Has an Opinion. When people ask me something, I now rarely answer directly. A good theory doesn’t change its mind: it doesn’t apply only to some companies or people, and not to others. It is a general statement of what causes what, and why. Good theory can help us categorize, explain, and, most important, predict.

You shouldn’t need Liz Taylor’s record on marriage to know what it takes for a good marriage. Theories help us explain what will happen before you experience it. He suggests you ask:

What are the most important assumptions that have to prove right for these projections to work—and how will we track them?

You’ll learn a lot of interesting things about business strategy, which surprised me at first given the subject of the book. Yet given his approach of using theories, it makes perfect sense.

One of the most intriguing discussions is the “full versus marginal thinking” that will help assure you live a life of integrity. He compares Netflix with Blockbuster.

Netflix didn’t have an existing profitable business model to compare to, it’s baseline was no profit. Blockbuster, on the other hand, based its decisions on marginal costs and revenues, which is dangerous because it

biases companies to leverage what they have put in place to succeed in the past, instead of guiding them to create the capabilities they’ll need in the future. If we knew the future would be exactly the same as the past, that approach would be fine. But if the future’s different and Blockbuster should have been thinking: If we didn’t have an existing business, how could we best build a new one? What would be the best way for us to serve our customers?

He then asks an interesting question:

Why is it that the big, established companies that have so much capital find these initiatives to be so costly? And why do the small entrants with much less capital find them to be straightforward?

The answer is when you’re new to the scene, the full cost is the marginal cost. This is the beauty of creative destruction, and it’s why economists don’t care if a business exists in the long run or not. Something will always come along that’s better.

So what’s this have to do with integrity?

The marginal cost of doing something ‘just this once’ always seems to be negligible, and hence it’s easier to hold to your principles 100 percent of the time than it is to hold to them 98 percent of the time. Decide what you stand for. And then stand for it all the time.

Good advice. Teaching ethics has convinced me of the wisdom of Oscar Wilde: “No man is rich enough to buy back his past.”

He ends on the importance of purpose, for which he recommends three parts:

What do you want the enterprise to have become at the end of the path it is on?

Commitment

One or a few metrics that can measure progress

God, in contrast to us, does not need the tools of statisticians or accountants. [He has] no need to aggregate. His only measure of achievement is the individual.

Christensen, like Mitt Romney and Harry Reid, is a devout Mormon. He also discusses being diagnosed with follicular lymphoma, a cancer similar to that which had killed his father. It went into remission, then he suffered an ischemic stroke right after beginning this book. He’s learning to speak again, one word at a time. I wish him well, and pray he has a speedy recovery.

He’s certainly helped clarify my thinking, and this book, while not your typical self-help book, is quite useful (in fact, all of his books are). Rather than telling you what to do, he helps you construct a theory of cause and effect. It’s much more difficult than reading platitudes, but far more useful. Highly recommended.

The following is from one of our latest Practicing Fellows, Matthew Tol, from Australia.

Apparently, the 50 Shades trilogy is one of the fastest selling books (for those with matching chromosomes) ever. Quite a feat when you see that all “serious” reviewers describe it as appallingly written. It must have something to do with the escapism that the books engender—something a lot of writers apparently strive for.

In many respects, the consultants to the professions (and I”m mainly talking about accounting and legal professions here), fall into the same mould as that adopted by E. L. James in her books. They offer up a fantasy, some escapism and possibly a somewhat removed from reality view of what a “normal” firm should look like. Although, I do think that a large number of firms out there have a number of “Red Rooms of Pain”—they’re known as Partners’ Offices at review time!

Having endured a range of sessions with consultants to the accounting profession over the past 20 plus years, it appears that they have a view of the world which is based largely on some experience they had many years ago. They have leveraged off this to create a story which they sell to everyone in an attempt to enable them to believe that they are able to do what the Consultant had done. Similar to Anastasia Steele, in the book, the submissives are taken on a journey for which they are unprepared and are convinced to adopt certain behaviours even if they are outside their comfort zone.

Whilst there are some things that the consultants to the professions do well—mainly cause people to think, their approach is possibly not relevant in the current environment. They have updated their stories based on stories they have been told rather than learnings they have experienced.

Take the younger staff engaged in professional firms. They are very different to where I and my colleagues were when we started out! They have a greater focus on results, less need to be measured and a greater desire to “make a difference.” They don’t like being managed with a stick and they have been taught that they are good enough.

How do we then reconcile that with the command and control processes that are promoted by the consultants? How do they “fit” with their performance being measured by productivity rather than results? Do they feel like Ana who is satisfied after received 20 whacks on the bum because that is what makes her “owner” feel good?

For the consultants to the profession to be truly effective and act as the catalyst they should be, they need to assist the firms they work with to develop new and innovative strategies to manage and inspire their staff. Sorry, but a goal of 80% productivity just doesn’t do it!

A large part of this revolves around being aware of the “soft” skills needed in developing people. Most of us have been trained to be technically very competent and have further developed that with many years of practice. When you get good enough technically, you get to a senior or ownership position and you are often simply not aware of the methods that need to be adopted to mentor and develop younger staff.

“When your only tool is a hammer, the rest of the world looks like a nail” is an old adage. Lots of firms base their existence around timesheets. This is a measurement tool that is so subjective as to be fictional and which bears no connection to quality or creativity in problem solving by the people on the job.

Senior people in firms have been managed and developed using the blunt object that is the timesheet and are now passing this insanity on to the next generation. The trouble is the next generation is not buying it.

I received an email the other day from one of the consulting groups to the profession talking about concepts like “value billing” and the like. Great. But then they go on to discuss the need to measure the time spent on the job to see whether it is profitable.

Taking this the other way—you agree a price with the customer based on the results you’re going to deliver. You then spend time recording the time you spend so that you can get to the end of the job to spend more time determining whether it was profitable? At what hourly rate were you working? This is like driving your car in the rear vision mirror.

Don’t get me wrong, there are significant benefits from doing after-action reviews at the completion of a job. If it’s done based on time spent, you’re losing the value you can get from these. You need to look at the qualitative factors instead. This is what the younger people in professional firms want.

We also need to remember that the younger people entering our professions have spent a large part of their developmental years playing computer games. These games teach them strategy and process and help them to understand that there are ways around things for those “in the know.” How good would it be if we were to utilise these skills in problem solving for our customers (or, heaven help, our own firms!)?

I must admit that I have not read any of E. L. James’ books—and probably won’t. The information I have used in here has come as per a consultant—I have spoken to people who have read it. Hence, I am not an expert on that topic.

However, the message that is in those books about consensual agreement to being flogged bears a striking (couldn’t resist the pun) resemblance to the way the professions are going and the perpetuation of this silliness by the consultants to the professions.

At some point in the not too distant future, the 50 Shades trilogy will be consigned to the discount bins. I can only hope that the focus of the consultants on timesheets and forgetting about the new generation is also remaindered. For the sake of the future of our professions, we need to move from the Greyness that leads to Darkness and be Freed.

Reed Holden is my mentor, so I’m extremely biased. Still, this is a great book, especially for any firm pricer who has to deal with procurement, which Reed writes is the new normal.

The final frontier of good pricing is the customer negotiation, and Reed explores this with verve, and an enormous amount of tacit knowledge accumulated from years as a salesman and pricing expert.

He points out “that 80 percent of procurement managers give the other 20 percent a bad name.” I have to say, this has not been my experience with the procurement folks I’ve met, but that’s probably because I only deal in the professional sector, not with general procurement.

What makes this book so useful is Reed documents all of the games procurement plays—from delays, waiting for the end-of-period discounts, to using vendors as “Rabbits” simply to drive down the price of the preferred vendor. There’s many effective tactics offered to deal with each of these scenarios.

And this advice needs to be shouted from the rooftop:

Discounting is a fool’s response. Those who live and die by discounting don’t live very long. Trad[ing] margins for revenues, they undermine the success of their business, which needs profits more than revenue to survive.”

The most important strategy, though, is to know your value, and to be an equal with procurement, not a supplicant. Only equals can negotiate. If you don’t know your value, procurement will drag you to the one topic they know well: price. You must change the conversation to value.

I also love this advice:

Spending the time on the proposal is actually easier than going to the customer with the tough questions.

Here are some of the questions Reed insists you answer before submitting a proposal:

What is the process for evaluating vendors and proposals?

What are the names and positions of everyone in the process?

Who is the ultimate decision maker?

What is their timeframe for evaluating vendors and finalizing the deal?

How many other vendors are approved to supply the product or service?

What are their names?

Do any of those other vendors have existing relationships with the decision maker?

Which vendor is the preferred vendor?

What are your criteria for selection of vendors?

Are you interested in vendors that might be able to provide more value to your firm?

When and how do we get an opportunity to understand how we can add more value?

Are you satisfied with your current vendor?

If you have no prior relationship with the customer, why are they asking you to bid?

Do budget dollars exist for the requested products and services?

How much is the budget?

What is the process to get approval to use budget dollars?

If you don’t know the answers [to three or more of these], pack up your bags and look for another opportunity.

The book documents eight different scenarios you can find yourself in. You’ll learn excellent strategies for dealing with price buyers, value buyers, and relationship buyers. The tough buyer is the poker player, who are value or relationship buyers in drag.

Counter intuitively, price buyers may be the easiest to deal with, since at least they are upfront about their expectations of the lowest price. Reed cites research that only 30%-35% of buyers were real price buyers, and that’s in commodity markets. For professional firms, it’s much less, probably single digits.

Reed’s ten tactics for winning the procurement game are exactly right:

Qualify, qualify, qualify

Understand your foundation of value

Develop give-get options [lower price, strip out value]

Map the buying center

Where appropriate, build trust

Use the policy ploy

Delay, delay, delay

Redefine risk

Dealing with reverse auctions

Do your homework

Being a William F. Buckley fan, I appreciated the story of when he was hired to speak at the University of Texas in the mid-1960s, when he was just starting his career as a lecturer. The Daily Texan university newspaper criticized the amount young Buckley was being paid, which was a record amount.

At his talk, Buckley read the most accusatory part of the article aloud, and said to a thundering applause:

I never said I was worth it. I only said I wouldn’t do it for less.

My only quibble with this book—Reed and I have discussed this before—is his use of the poker analogy. He writes:

The way is to consider the negotiation with the economic buyer as a game of poker.

Wagering, like a customer negotiation, is a zero-sum game. That is, every dime that ends up in one pocket is taken out of another.

Remember, you’re in a zero-sum game. The goal of procurement is to grab as much of the pot as possible.

Yet enterprise is not a zero-sum game, otherwise their could be no growth or value created. In the long run, both parties to a transaction benefit, no matter what price is finally agreed upon.

The zero-sum mentality has many deleterious effects, and I believe this analogy needs to be buried. Linguistics matter—a lot.

We must change the conversation to value, something both sides want to maximize. It’s the one area where interests are aligned—the opposite of a zero-sum game.

That quibble aside, this is a fantastic book, and a must-read. Even if you don’t deal with procurement, you will learn strategies from one of the world’s foremost pricing experts.

It’s also an optimistic book, as Reed believes that high value products and services are not dead. With all the talk of the “new normal,” this is a refreshing and empowering message.

I am proud to be speaking at the 3rd Pricing & Revenue Optimization Summit on July 30th, being held in Chicago.

The workshop I am leading is titled “Behavioral Economics: A Look at the First and Second Law of Pricing” focusing on how the anchoring and framing effect influence pricing, and to help attendees gain an inside look at behavioral economics to create a pricing strategy that satisfies corporate goals as well as customers.

Visit here for more details and use the code “3PROS_Verasage” to receive a speaker referral discount.

Warning: Similar to her first book in this series, The Bourgeois Virtues, Bourgeois Dignity is an extremely difficult—even painful at times—read. It’s dense; long (450 pages); packed with scholarly citations; it rambles, and wanders, sometimes aimlessly, with 41 pages of footnotes that take you even farther afield; it probably should have been cut in half by the editor; not to mention in places it will give you an incredible migraine.

It’s also brilliant. I loved it.

But I dread trying to summarize the argument because it’s so complex and expansive in scope. For, as usual, McCloskey has looked at the hypothesis from every possible angle. This is the second book in a planned six-book series, which sets out to answer this question:

What caused the spectacular growth in the economy from the late 18th century to the present day, going from an income of approximately $1 to $3 per day to $137 today?

It’s even larger than that if you take into account the quality of goods and services available today versus then. One simple example is antibiotics. Simple infections that once killed incredibly wealthy people can now be cured with $5 and a trip to the drugstore.

Estimates put the growth in the quality of goods and services at a factor of 40 to 190—I believe even that is an understatement.

In 1875, the average family spent 74% of its income on food, clothing and shelter. In 1995 they spent 13%. This is one reason why my colleague Ed Kless says he’d rather be poor anywhere in the world today than in 1800.

This is an incredible accomplishment, and historians, economists, sociologists, poets, along with many others, have offered a plethora of explanations to explain it. McCloskey explores them all, but she reaches a totally different conclusion than most economists. In fact, the subtitle of the book is “Why economics can’t explain the modern world.”

McCloskey believes that economic change depends on what people believe—their talk, their ethics, and their ideas, especially as related to dignity and innovation. It’s what Alexis de Tocqueville called “habits of the mind.”

Yet “ideas about ideas are unscientific” and largely ignored by economists who naturally gravitate towards materialist explanations for growth and dynamism. McCloskey writes:

To be able to detect the dark matter we will need a new, more idea-oriented economics, which would admit for example that language shapes an economy.

Words Matter

One of our favorite lines discovered recently is Werner Erhard’s “All transformation is linguistic. If we want to change our culture, we need to change our conversation.”

McCloskey’s argument is this on steroids. In other words, our conversations about dignity and liberty changed, launching the Industrial Revolution. Here’s how McCloskey expresses this phenomena:

A big change in the common opinion about markets and innovation, I claim, caused the Industrial Revolution, and then the modern world. The change occurred during the seventeenth and eighteenth centuries in north-western Europe. More or less suddenly the Dutch and British and then the Americans and the French began talking about the middle class, high or low—the “bourgeoisie”—as though it were dignified and free. The result was modern economic growth.

That is, ideas, or “rhetoric,” enriched us. The cause, in other words, was language, that most human of our accomplishments.

In the spirit of words being crucial, she’s attempting to rid the world of the dreaded “Capitalism,” preferring “Innovation” instead to explain the wonders of a free market.

Not the Cause

The heart of the book is a deep analysis of why all the traditional explanations of the Industrial Revolution fail to explain the caus. To contrast these viewpoints, consider the book by William J. Bernstein, The Birth of Plenty. This is a fairly representative example of how most commentators explain the origins of the Industrial Revolution, though McCloskey doesn’t cite this work.

Bernstein, like McCloskey, concludes it’s not geography, climate, exposure to microbiological agents (as Jared Diamond has argued in his books), but rather four factors:

Property rights

Scientific rationalism (positing and falsifying theories)

Capital markets

Improvements in transportation and communication

Which of the four was most important? All of them are like ingredients to a cake, all are equally important to produce a just dessert. It’s not physical objects (materialism) that matters, but rather institutions, according to Bernstein.

This sounds very plausible, but not to McCloskey, and she debunks every one of these factors. In chapter after chapter, she definitively falsifies the following list of reasons often cited as the cause of the Industrial Revolution:

The Weber Thesis—The Protestant (particularly Calvinism) ethic

Michael Porter’s thesis of competitive strategy of nations (this is deftly ripped apart by McCloskey, and R.I.P. as far as I’m concerned)

Rise of rationality

The exchange of ideas. Ideas having sex, in Matt Ridley’s apt phrase from The Rational Optimist. It helps, but it’s simply not large enough to have caused the Industrial Revolution

Education. In fact, too much education can impair growth. An interesting discussion is provided by McCloskey, and Thomas Sowell’s work as well

Thrift (savings accumulation)

Investment (capital accumulation)

Economies of scale

Division of labor

Greed

Expropriation or imperialism

Human capital. Not that this is unimportant, but McCloskey would argue (using our lingo) that social capital—specifically, our conversations and beliefs—are more important. I think Rabbi Lapin would call this “spiritual capital”

Transportation

Foreign trade. This simply reshuffles goods and services, it doesn’t discover or lead to innovation

Geography. Jared Diamond’s thesis is thoroughly shot down

Natural resources. McCloskey believes there’s no such thing as a natural resource, except the imagination of man

Unions

Eugenics

Institutions. No doubt important, but no way did they cause the spectacular growth, and mostly were formed afterwards

Property rights. Again, they are important, but they existed in all sorts of places prior to Great Britain (China, e.g.)

Science. This is more a result, not a cause

Thankfully, she also takes down the happiness literature that’s beginning to sprout up in economics, which is just so much hokum.

One discussion that runs through the narrative is the “California School”—why so many scholars (who tend to be disproportionately located in California universities) believe that numerous discoveries were originally from China, giving error to the idea of European exceptionalism.

McCloskey is more and more convinced of the findings of this school of thought, and so will you after reading about it.

Bowing to her colleagues, who love to express economics in mathematics, McCloskey offers this rather innovative “model” (not a theory) to explain the function for national product:

Q = I (D, B, R) • F (K, sL)

In which I is the Innovation function, depending on D, the dignity accorded innovators, and on B, the liBerty of innovators (the letter L is need for labor), and on R, the rent or profit to innovation.

The innovation function multiplies a conventional neoclassical production function, F, depending on ordinary physical capital and land, K, and on raw labor, L, multiplied by an education-and-skill coefficient, s.

It was anticipated by [Adam] Smith, whose Theory of Moral Sentiments (1759) treats the D variable of dignity, and whose Wealth of Nations (1776) treats the B variable of liberty (amongst a great deal also about F(.)).

And as example of how erudite this book is, where else could you read about Frédéric Bastiat’s idea of a “negative railroad.” Bastiat is on of my favorite economic thinkers because he takes arguments, especially those advocating protectionism, to their logical and absurd extreme.

In 1845 he wrote a petition of the candle makers against the unfair competition (think “dumping”) of the light of the sun, arguing that the law should require curtains to be drawn during the day.

He also argued that if exports would good and imports bad (think our completely meaningless “balance of trade” deficit, which describes accounting, not economics), then countries should sink their ships at sea, creating exports with no imports. Brilliant!

He was probably among the best thinkers to explain that job creation is not the purpose of an economy. In another spoof, he argued that the King should cut off everyone’s right arm, since then it would take twice as long to accomplish any task, create all sorts of jobs, and wealth.

Well, the “negative railroad” is just as funny, and only politicians would be dumb enough to fall for it (think “Wright Amendments” for flying out of Texas). Here’s how McCloskey explains it:

A railroad was proposed in the early 1840s from Paris to Madrid. The city of Bordeaux, at a third of the distance, demanded that the railroad break there, on the argument that the break would “create jobs” for porters and hotels and cabs [big cities like Paris, London and Chicago have always had the trains go into them and end].

Bastiat noted that according to such “job-creating” logic every town along the route should see its opportunity and take it. Every few kilometers, at every country village, the railroad on the way to Madrid would end at a Gare du Nord to be resumed as a Gare du Sud, after job-creating expenditure for freight and travelers en route.

All the national income of France and Spain would come to be “generated” by the Paris-to Madrid railroad, at the cost of all other forms of production and consumption. Jobs would be “created.” It would be a negative railroad, a triumph of protectionism and industrial planning achieved through what economists would later call “rent seeking” by the politicians of Bordeaux or Ablon-sur-Seine.

Think Obama’s “investment” in Solyndra to “create” green jobs.

In the final chapter, she summarizes the “Bourgeois Deal”:

Give a woman some rice, and you save her for a day. Give a man some seed and you save him for a year. That’s the plan of investment in capital, tried for decades in foreign aid, without much success.

But give a man and a woman the liberty to innovate, and persuade them to admire enterprise and to cultivate the bourgeois virtues, and you save them both for a long life of wide scope, and for successively wider lives for their children and their grandchildren, too. That’s the Bourgeois Deal, which paid off in the Age of Innovation.

Does the idea of conversation, words, and talk, changing the course of civilization sound too simplistic? Think about this: Why have out-of-wedlock births skyrocketed in the past 50 years?

Even during the worst years of slavery, the black family was largely intact. And, as Charles Murray documents in Coming Apart, out-of-wedlock births are increasing dramatically among the white population.

Why? What changed? Was it our conversation about this issue? Removing the stigma and shame associated with “bastard” children?

If not, what? Even Murray doesn’t completely blame the welfare state, concluding it exacerbated and enabled, not caused.

I find McCloskey’s work compelling, and it certainly has changed my worldview on the causes of the Industrial Revolution. It truly gives weight to the saying “all transformation is linguistic.”

If you’d like to follow this line of thought, you can visit her site here.

The planned six-book series is as follows:

The Bourgeois Virtues

Bourgeois Dignity

Bourgeois Revaluation, how innovation became virtuous 1600-1845, where she will attempt to measure dignity, and even liberty

3M is the third most innovative company in the world, behind Apple and Google. It sells fifty-five thousand different products—giving it a nearly 1:1 product-to-employee ratio—and generates 30 percent of its annual revenue from products that didn’t exist 5 years ago.

The essential feature of 3M’s innovation is its “flexible attention policy.” Instead of requiring constant concentration, and working to improve efficiency ratios, it encourages people to make time for activities that are unproductive—going for a walk, reading, etc.

David Vilensky, managing partner of BBV in Perth, Australia, and a Trailblazer, recently responded to an article in Lawyers Weekly, “Clients falling back on ‘safe’ hourly rates.”

Have you ever read such laughable crap. Clearly Mallesons have got a better PR machine that anyone else. Talk about vested interests.

As is well documented, these big firms survive on billable hours—the alternative is a slow death.

I recently posted a comment on Linkedin about the concept of “nobody’s money”. Why would the CEO or CFO of Woodside, or Rio, or NAB, or QBE, or whoever, give a toss about the amount of legal fees being spent when they are not actually paying? It’s shareholders money being used (nobody’s money) and when a company has $15m in the bank who cares if the lawyers bill is $20k or $50k or $100k.

But wait until the CFO gets divorced and goes to a family law lawyer who bills by the hour (as most do)—then they sing a different tune. Why? Because they are paying with their own money.

Regarding in house counsel, it’s the same story really. Most come from the big firms and are now working for former clients of their old firms. Clients that use “nobody’s money” to pay their legal bills.

I look forward to the day when the CEO of a large public company calls in his team of in house counsel and says to them that their bonuses will be based on the amount of legal fees they can SAVE the company. Watch them then!

Ron, this reminds me of your statement (BRW a month or so ago) which said “If you’re afraid of change you’re really not going to like irrelevance.”